Fund of Information

Fund Investors Finally Catch On

Institutional investors have been decrying the lack of opportunity in fixed income for years now, but investors have poured more and more money into bond funds. It appears that trend is finally about to turn.

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Financial advisors and investment strategists started talking about a looming bond bubble as early as 2010, and those warnings came to a crescendo last year when, after three decades of steady declines, yields on the 10-year Treasury dipped below 2%. Many experts, including Pimco's Bill Gross and Goldman Sachs senior U.S. investment strategist Abby Joseph Cohen, have counseled investors to steer clear of long-term bonds. Many have deemed U.S. Treasuries and investment-grade corporate bonds riskier than stocks.

"It's not just a matter of bonds being overvalued but that these yields will not get you through retirement," says Jeremy Kisner, president of SureVest Capital Management in Phoenix. Even his most conservative portfolios have just 20% allocated to bonds.

Yet, looking at mutual-fund flows for the past few years, it seems individual investors -- who represent the bulk of mutual-fund investors -- have turned a deaf ear. Between January 2010 and year-end 2012, investors poured $615 billion into taxable-bond mutual funds, according to the Investment Company Institute (ICI). That was largely at the expense of domestic equity mutual funds, which saw a net loss of $369 billion over that time.

By and large, investors did just fine ignoring the experts. Over the past three years through Feb. 7, the Barclays U.S. Aggregate Bond Index is up 5.4% a year, and the Barclays U.S. Government Bond Index is up 4.6% a year. Long-term corporate bonds were up an astounding 9.8% a year over that time. Recently, bonds have given back some of those gains -- both of those Barclays indexes are down 0.6% for 2013 -- but the sky hasn't exactly fallen.

TO BE FAIR, SEVERAL FACTORS contributed to the mass exodus to bonds in recent years. "One is a demographic factor, which is the aging of the baby-boom generation," says ICI senior economist Shelly Antoniewicz. "They're shifting some of their assets out of equities and into fixed income, which is to be expected." At the same time, she says, mutual-fund investors have become more diversified; they've moved into balanced funds, international equity, and alternative assets as well. Finally, more individuals are using exchange-traded funds, which have seen net inflows into equities over the past three years.

Even so, it's safe to say that one of the biggest forces behind the shift from stocks to bonds has been pure and simple emotion. "The best friend of the bond market for the past decade has been fear," says Jim Paulsen, chief investment strategist at Wells Capital Management.

It's still too soon to tell, but the much anticipated "rotation" may be upon us. During the first four weeks of January, mutual-fund investors poured $20.7 billion into equity mutual funds, according to Lipper. That's the highest four-week jump since April 2000. Add exchange-traded funds to the mix, and that total is $34.2 billion, the largest four-week jump since January 1996.

It seems as if mutual-fund investors (again, the vast majority of which are individuals) are beginning to follow institutional investors, which are often, if imperfectly, represented by exchange-traded fund flows. Last year, while investors yanked $126 billion out of equity mutual funds, according to Lipper, they poured $301 billion into bond mutual funds. Meanwhile, ETF investors added $111 billion to equity ETFs, and just $44 billion to bond ETFs.

THE FIRST QUARTER, and January in particular, is always a big month for inflows into mutual funds, notes ICI's Antoniewicz. Now is when investors in individual retirement plans tend to bulk up on their savings prior to the April 15 tax deadline. Inflows this year, moreover, may be especially large because investors sold late last year in anticipation of higher rates this year. "In order to make any kind of definitive statement about whether people are rotating back into equities, we need to see this pattern for a good five or six months," she adds. "If in May or June we still have positive inflows, then we could talk about the start of a trend."

Still, after 20 consecutive months of domestic equity withdrawals, one can't help being optimistic. "January is a bit suspect, but I think we're seeing some significant changes going on at the margin," says Paulsen. Fund flows, he's quick to point out, don't have a meaningful impact on markets in and of themselves. The net inflows for January are a drop in the bucket compared with, say, the $117 billion
American Funds Growth Fund of America
(ticker: AGTHX). "It's not the sheer supply and demand but the attitude it portrays," he says.

Bears might argue that with the S&P near all-time highs and individual investors finally coming around, signs point to the top of the market, and no doubt most market peaks are marked by cash influxes into stock funds. Paulsen, along with other bulls, doesn't think that's the case now.

No doubt, many fund investors are kicking themselves for not being a little more optimistic a year ago, before the Standard & Poor's 500 returned 16%. "Retail investors are usually late to the party," says Kisner.